February 14, 2020 Reading Time: 7 minutes

Although the movement to “End the Fed” has a considerable popular following, only a very tiny number of economists—our illustrious contributors amongst them—take the possibility seriously. For the rest, the Federal Reserve System is, not an ideal currency system to be sure (for who would dare to call it that?), but, implicitly at least, the best of all possible systems. And while there’s no shortage of proposals for reforming it almost all of them call only for mere tinkering. Tough though their love may be, the fact remains that most economists are stuck on the Fed.

This veneration of the Fed has long struck me as perverse. Its record can hardly be said, after all, to supply grounds for complacency, much less for the belief that no other system could possibly do better. (Indeed that record, as Bill Lastrapes, Larry White and I have shown, even makes it difficult to claim that the Fed has improved upon the evidently flawed National Currency system it replaced.) Further, as the Fed is both a monopoly and a central planning agency, one would expect economists’ general opposition to monopolies and to central planning, as informed by their welfare theorems and by the general collapse of socialism, to prejudice them against it. Yet instead of ganging up to look into market-based alternatives to the Fed, the profession, for the most part, has relegated such inquiries to its fringe.

Why? The question warrants an answer from those of us who insist that exploring alternatives to the Fed is worthwhile, if only to counter people’s natural but nevertheless mistaken inclination to assume that the rest of the profession isn’t interested in such alternatives because it has already carefully considered—and rejected—them.

It’s tempting to blame Fedophilia, and the more general phenomenon of what Larry White calls “status quo” bias in monetary research, on the Fed’s direct influence upon the economics profession. According to White, in 2005 the Fed employed about 27 percent more full-time macro- and monetary (including banking) economists than the top 50 US academic economics departments combined, while disseminating much of their research gratis through various in-house publications or as working papers. Perhaps not surprisingly, despite a thorough review of such publications, White could not find “a single Fed-published article that calls for eliminating, privatizing, or even restructuring the Fed.” That professional monetary economics journals are not much better may, in turn, reflect the fact, also documented by White, that Fed-affiliated economists also dominate those journals’ editorial boards.

But I doubt that a reluctance to bite the hand that feeds them is the only, or even the most important, reason why most economists seldom question the Fed’s desirability. Another reason, I suppose, is their desire to distance themselves from… kooks. Let’s face it: more than a few persons who’d like to “End the Fed” want to do so because they think the Rothschilds run it, that it had JFK killed because he planned to revive the silver dollar, and that the basic plan for it was hatched not by the Congressional Committee in charge of monetary reform but by a cabal of Wall Street bankers at a top-secret meeting on Jekyll Island.

Oh, wait: the last claim is actually true. But claims like the others give reasonable and well-informed Fed critics a bad name, while giving others reason for wishing to put as much space as possible between themselves and the anti-Fed fringe.

I’m convinced that imagination, or the lack of it, also plays a part. To some extent, the problem is too much rather than too little imagination. With fiat money, and a discretionary central bank, it’s always theoretically possible to have the money stock (or some other nominal variable) behave just like it ought to, according to whichever macroeconomic theory or model one prefers. In other words, a modern central bank is always technically capable of doing the right thing, just as a chimpanzee jumping on a keyboard is technically capable of typing-out War and Peace.

Just as obviously, any conceivable alternative to a discretionary central bank, whether based on competition and a commodity standard or frozen fiat base or on some other “automatic” mechanisms, is bound to be imperfect, judged relative to some—indeed any—theoretical ideal. Consequently, an economist need only imagine that a central bank might somehow be managed according to his or her own particular monetary policy ideals to reckon it worthwhile to try and nudge it in that direction, but not to consider other conceivable arrangements.

That there’s a fallacy of composition of sorts at play here should be obvious, for a dozen economists might hold as many completely different monetary policy ideals; yet every one might be a Fedophile simply because the Fed could cater to his or her beliefs. In actual fact, of course, the Fed’s conduct can at most satisfy only one of them, and is indeed likely to satisfy none at all, and so might actually prove distinctly inferior to what some non-central bank alternative would achieve. So in letting their imaginations get the best of them, all twelve economists end up endorsing what’s really the inferior option.

If you don’t think economists are really capable of such naivete, I refer you to the literature on currency boards, in which one routinely encounters arguments to the effect that central banks are always better than currency boards because they might be better. Or how about those critics of the gold standard who, having first observed how, under such a standard, gold discoveries will cause inflation, go on to conclude, triumphantly, that a fiat-money issuing central-bank is better because it might keep prices stable?

But if economists let their imaginations run wild in having their ideal central banks stand in for the real McCoys, those same imaginations tend to run dry when it comes to contemplating radical alternatives to the monetary status quo. Regarding conventional beliefs concerning the need for government-run coin factories, which he (rightly) dismissed as so much poppycock, Herbert Spencer observed, “So much more does a realized fact influence us than an imagined one, that had the baking of bread been hitherto carried on by government agents, probably the supply of bread by private enterprise would scarcely be conceived possible, much less advantageous.” Economists who haven’t put any effort into imagining how non-central bank based monetary systems might work find it all too easy to simply suppose that they can’t work, or at least that they can’t work at all well. The workings of decentralized markets are often subtle; while such markets’ ability to solve many difficult coordination problems is, not only mysterious to untrained observers, but often difficult if not impossible even for experts to fathom except by means of painstaking investigations. In comparison monetary central planning is duck soup—on paper, anyway.

Nor does the way monetary economics is taught help. In other subjects, the welfare theorems are taken seriously. In classes on international trade, for example, time is always spent, early on, on the implications of free trade: never mind that the world has never witnessed perfectly free trade, and probably never will; it’s understood that the consequences of tariffs and other sorts of state interference can only be properly assessed by comparing them to the free trade alternative, and no one who hasn’t studied that alternative can expect to have his or her pronouncements about the virtues of protectionism taken seriously.

In classes in monetary economics, on the other hand, the presence of a central bank—a monetary central planner, that is—is assumed from the get-go, and no serious attention is given to the implications of “free trade in money and banking.” Consequently, when most monetary economists talk about the virtues of this or that central bank, they’re mostly talking through their hats, because they haven’t a clue concerning what other institutions might be present, and what they might be up to if the central bank wasn’t there.

Since monetary systems not managed by central banks, including some very successful ones, have in fact existed, economists’ inability to envision such systems is also evidence of their ignorance of economic history. That ignorance in turn, among younger economists at least, is a predictable consequence of the now-orthodox view that history can be safely boiled down to a bunch of correlation coefficients, so that they need only gather enough numbers and run enough regressions to discover everything worth knowing about the past.

Those who’ve been spared such “training,” on the other hand, often have a purblind view of the history of money and banks—one that brings to mind Saul Steinberg’s famous New Yorker cover depicting a 9th-Avenuer’s view of the world, with its almost uninhabited desert between the Hudson and the Pacific, and China, Japan, and Russia barely visible on the horizon. If he or she knows any monetary history at all, the typical (which is to say American) economist knows something about that history in the U.S., and perhaps considerably less about events in Great Britain. Theirs is, in short, just the right amount of knowledge to be very dangerous indeed.

And dangerous it has been. In particular, because the U.S. before 1914, and England before the Bank of England began acting as a lender of last resort, happened to suffer frequent financial crises, economists’ historical nearsightedness has given rise to the conventional wisdom that any fractional-reserve banking system lacking a lender of last resort must be crisis-prone, and two clever (if utterly fantastic) formal models serving to illustrate the same view (or, according to economists’ twisted rhetoric, to “prove” it “rigorously”). It has, correspondingly, led economists to ignore or at least to underestimate the extent to which legal restrictions, including unit banking laws in the U.S. and the six-partner rule in England, contributed to the deficiencies of those countries’ banking systems. Finally, and most regrettably, it has caused economists to overlook altogether the possibility that the monopolization of paper currency has itself been more a cause of than a cure for financial instability.

The good news is that Fedophilia is curable. Milton Friedman, for one, was a recovering Fedophile: later in his career, he repudiated the mostly-conventional arguments he’d once put forward in defense of a currency monopoly. Friedman, of course, was a special case: a famous proponent of free markets, he had more reason than most economists do to view claims of market failure with skepticism, even if he’d once subscribed to them himself. Even so, his was only a half-hearted change of heart, in part (I believe) because he still hadn’t drawn the lessons he might have from the banking experiences of countries other than the U.S. and England.

Friedman’s case suggests that it will take some pretty intense therapy to deprogram other Fed inamoratos, including a regimen of required readings. Charles Conant’s History of Modern Banks of Issue will help them to overcome their historical parochialism. Vera Smith’s The Rationale of Central Banking will do more of the same, while also exposing them to the lively debates that took place between advocates and opponents of currency monopolies before the former (supported by their governments’ ravenous Treasuries) swept the field. The Experience of Free Banking, edited by Kevin Dowd (with contributions by several Alt-M contributors including yours truly) gathers studies of a number of past, decentralized currency systems, showing how they tended to be more stable than their more centralized counterparts, while another collection, Rondo Cameron’s Banking in the Early Stages of Industrialization, shows that less centralized systems were also better at fostering economic development. Finally, instead of being allowed to merely pay lip service to Walter Bagehot’s Lombard Street, Fedophile’s should be forced, first to read it from cover to cover, and then to re-read out-loud those passages (there are several) in which Bagehot explains that there’d be no need for lenders of last resort had unwise legislation not created centralized (“one reserve”) currency systems in the first place. The last step works especially well in group therapy.

Of course, even the most vigorous deprogramming regimen is unlikely to alter the habits of hard-core Fed enthusiasts. But it might at the very least make them more inclined to engage in serious debate with the Fed’s critics, instead of allowing the Fed’s apologists to go on believing that they answer those critics convincingly simply by rolling their eyes.

This piece originally ran on Alt-M

George Selgin


George Selgin is a senior fellow and director of the Center for Monetary and Financial Alternatives at the Cato Institute and Professor Emeritus of Economics at the University of Georgia. He was the featured speaker at AIER’s 2018 Sound Money Project Annual Meeting. He was a Visiting Scholar for AIER in Summer 2019

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